Abstract

http://ssrn.com/abstract=2184254
 
 

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Implications of Returns Predictability across Horizons for Asset Pricing Models


Carlo A. Favero


Bocconi University - Department of Finance; Centre for Economic Policy Research (CEPR)

Fulvio Ortu


Bocconi University - Department of Finance

Andrea Tamoni


London School of Economics & Political Science (LSE)

Haoxi Yang


Nankai University

April 12, 2016


Abstract:     
In this paper we show how the evidence on predictability of returns at different horizons can be used to discriminate among competing asset pricing models. We analyze predictors-based variance bounds, i.e bounds on the variance of the stochastic discount factors (SDFs) that price a given set of returns conditional on the information contained in a vector of return predictors. In particular, we show that the evidence on predictability of raw returns and downward sloping term structure of conditional variances of returns at different horizons translates into bounds on the variance of the SDFs that are much tighter than the respective unconditional bounds. Importantly, we also show that these predictors-based bounds constitute a legitimate lower bound on the variance of the SDF of a given asset pricing model, as long as the predictability of model-discounted returns is rejected. We then examine three leading classes of asset pricing models: external habit formation, rare disaster, and long-run risk. We show that for all these three models the hypothesis of absence of predictability of discounted returns cannot be rejected, while predictors-based bounds allow us to assess the performance of these models at long and short horizons and to discriminate between them.

Number of Pages in PDF File: 63

Keywords: returns predictability, predictors-based bound, asset pricing models

JEL Classification: G12, E21, E32, E44


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Date posted: December 4, 2012 ; Last revised: April 12, 2016

Suggested Citation

Favero, Carlo A. and Ortu, Fulvio and Tamoni, Andrea and Yang, Haoxi, Implications of Returns Predictability across Horizons for Asset Pricing Models (April 12, 2016). Available at SSRN: http://ssrn.com/abstract=2184254 or http://dx.doi.org/10.2139/ssrn.2184254

Contact Information

Carlo A. Favero
Bocconi University - Department of Finance ( email )
Via Roentgen 1
Milano, MI 20136
Italy
HOME PAGE: http://www.igier.unibocconi.it\favero
Centre for Economic Policy Research (CEPR)
77 Bastwick Street
London, EC1V 3PZ
United Kingdom
Fulvio Ortu
Bocconi University - Department of Finance ( email )
Via Roentgen 1
Milano, MI 20136
Italy
Andrea Tamoni (Contact Author)
London School of Economics & Political Science (LSE) ( email )
Houghton Street
London, WC2A 2AE
United Kingdom
02079557303 (Phone)
Haoxi Yang
Nankai University ( email )
Tongyan Road 38
Tianjin, Tianjin 300350
China
Feedback to SSRN


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